Vietnam urged to focus on FDI to achieve stability

The State Bank of Vietnam’s surprise decision to devalue the currency heightened concerns about investing in the country. But Moody’s Economy.com argues that policy-makers must encourage FDI to finance the trade deficit.

The nation’s economic progress has been called into question after the State Bank of Vietnam, the central bank, decided to devalue the dong by 5.4% to 17,961 against the US dollar on November 25.

This move caught some investors by surprise and has heightened concerns about investing in the country.

The devaluation was designed to curb a widening trade deficit, but some, such as Matt Robinson, an economist at Moody’s Economy.com, believe that encouraging greater FDI flows is of greater importance for policy-makers.

Foreign portfolio flows and FDI make up foreign investment inflows. This is a source of foreign currency and helps Vietnam to offset its growing trade deficit, which hit US$10.2 billion from January to November.

Robinson believes that the government needs to encourage FDI, which would help to shift reliance away from portfolio flows to finance the country’s trade deficit, as portfolio flows can move offshore at the first hint of trouble and can be destabilising to the economy.

“There is lingering uncertainty of what could happen if there was a very marked and disorderly exit of a lot of capital from the economy and it raises questions about financing the current account deficit and being able to maintain foreign reserves stability,” says Robinson.

Also, such portfolio flows do not “necessarily add to the productive stock of the economy”, in contrast to FDI.

The overwhelming issue is whether the Vietnamese government will be able to encourage foreign direct investment.

Robinson believes that the government’s policy-makers will need to tread a fine line between depreciating the currency, dampening inflation pressures and raising domestic interest rates so as to attract the necessary FDI. “If they can achieve that result, it would be an impressive outcome,” he says.

FDI into Vietnam has taken a hit this year because of the financial crisis. It dropped 10.4% to US$9 billion in the first 11 months of 2009 from the same period a year before, the government announced today (November 27).

Some investors have also been wary of investing in Vietnam because of inflation. Prices increased to a six-month high of 4.4% year-on-year in November.

To attract longer-term money, Vietnam will have to get its house in order, said Robinson. “There’s no substitute for sound economic fundamentals when it comes to FDI looking for a destination,” he points out.

In addition to controlling inflation, Robinson believes the government needs to reduce the red tape around investing in the country. “I get the impression that this issue is certainly in the minds of policy-makers,” he stated.

He highlights measures they could consider, including making it easier for foreign investors to understand the systems and processes of investing in the country; making the regulatory regime more responsive and attractive to FDI; and promoting competition.